“China had 182 million smokers in 1980, and nearly 282 million in 2012, it said. India gained 35 million smokers – bringing its total to 110 million – even though the smoking rate fell from 19 to 13 percent of the population.

Russia, where about one third of people smoke, has added 1 million smokers­ since 1980.

Globally, the number of smokers has climbed from 721 million in 1980 to 967 million in 2012. The number of cigarettes smoked annually has also risen 26 percent over the past three decades.

“The greatest health risks are likely to occur in countries with high prevalence and high consumption,” said the study. Countries include China, Greece, Ireland­, Italy, Japan, Kuwait, the Philippines, Uruguay, Switzerland and Russia, it said.”

That succinct storyline explains why Philip Morris International will be a better investment than Altria, Lorillard, and Reynolds American over the coming twenty, thirty, and forty years. Philip Morris Internation has a foothold in all of these markets (160 countries total) where the number of smokers is actually rising. With the American tobacco stocks, the volume shipments have been declining steadily at a rate of 3-4% annually since the early 1980s. That’s a huge difference.

Volume declines are a permanent, entrenched headwind that the domestic sellers of tobacco must face. They have been able to adopt different strategies to cope with it—Altria has a 27% stake in SABMiller that gives it a steady stream of ongoing dividends to fund operations, Lorillard has been buying back massive amounts of stock to increase their earnings per share rate, and Reynolds American has a steady diet of low-cost cigarette brands (I believe the industry term is “discount brands” or “non-premium brands”) that allows it to maintain and even grow its market share as volumes decline.

Additionally, the Big Three of the domestic tobacco manufacturers have relied on good ‘ole price increases and expansions into the e-cigarette market to try and stimulate growth, but still, they have to always navigate the political risk of smoking bans and higher prices, as is documented in the video below that uses the obvious example of New York to showcase the difficulty facing tobacco companies in handling regulation and taxation burdens imposed by the government.

http://www.youtube.com/watch?v=5MmYY8sj73g

That is not to say that Philip Morris International is without challenges. Later this year, China is expected to ban cigarette consumption in public. That’s the crux of the difficulty in being a tobacco investor—to succeed, you must hold for the long-term, but when you monitor your stocks, you will always see a constant barrage of new political risks introduced to your investment—a new ban here, a new tax there, and so on. That’s what makes tobacco investing hard: the storyline of Big Tobacco’s success is that the fear of regulation and taxation has always been underrated, but eventually a time might come profits actually start to fall and dividends have to be cut.

Strategically, here is how I would think about it. When Altria got spun off from Philip Morris International in 2008, the deal was this: Altria would operate in the U.S. market, and Philip Morris International would get dibs on every other country in the globe (that’s why it has operations in 160 countries). The tobacco regulations in third-world countries are picayune compared to those in America, and that is why you are seeing places like the Philippines and Singapore having exploding growth in volume demands for tobacco stocks.

It’s the same storyline that Christie Duffy reported on in 2008.

http://www.youtube.com/watch?v=6hEkOHhlua0

This is the line that you need to remember: “The firm, which makes seven of the top 15 brands of tobacco products in the world, sells its smokes in 160 countries. The company in 2008 held a more than 15% share of the international cigarette market outside the US. Its key brands include Marlboro (the world’s top-selling cigarette), Bond Street, Chesterfield, Lark, Merit, Parliament, Rothmans, Number 7, Philip Morris, and Virginia Slims, as well as popular regional brands.”

Philip Morris International has a deep bench of brands, and the flexibility to cope with regulations in 160 different countries. That is a huge advantage over the domestic counterparts that only operate in the United States. If I was someone unsure of how to invest in tobacco, here’s how I would do it: put 3-5% of the position in Philip Morris International and reinvest the dividends for a few years. Then, I’d start collecting them as cash and use the Philip Morris International dividends to fund new positions that hedge against the potential demise of the sector. Within about ten years or so of dividend growth, you’d have received the entirety of your Philip Morris International investment back in the form of cash dividends. From there, you are playing with the “house” money. It’s a great way to guarantee that you get some permanent utility out of your investments if you treat Philip Morris International’s growing dividend as a cash cow to harvest and develop new positions in Nestle, General Mills, Coca-Cola, PepsiCo, Procter & Gamble, and Johnson & Johnson. A $15,000-$25,000 investment in Philip Morris International today could allow you to use the dividends to create a mini blue-chip dividend portfolio over the next 25 years.

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